Systemic credit freezes in financial lending networks

Abstract

This paper develops a network model of interbank lending, in which banks decide to extend credit to their potential borrowers. Borrowers are subject to shocks that may force them to default on their loans. In contrast to much of the previous literature on financial networks, we focus on how anticipation of future defaults may result in ex ante "credit freezes," whereby banks refuse to extend credit to one another. We first characterize the terms of the interbank contracts and the patterns of interbank lending that emerge in equilibrium. We then study how shifts in the distribution of shocks can result in complex credit freezes that travel throughout the network. We use this framework to analyze the effects of various policy interventions on systemic credit freezes. * We are also grateful to Celso Brunetti, Sebastian Infante, Borghan Narajabad, and Carlos Ramirez for helpful suggestions.

Cascading failure in guarantee networks from the perspective of equilibrium

“…Moreover, the agent-based model, in which agents (instead of entities) interact with each other, is built to control the systemic risk (Thurner and Poledna, 2013).The bank-firm multiplex network of Chinese market is constructed to test the systemic impacts between banks and firms (Li et al, 2020). Furthermore, the interbank lending network model is used to discuss the equilibrium among lending patterns (Acemoglu et al, 2020). However, there is a gap about measuring the systemic risk in the guarantee networks with cascade-based attacks under the equilibrium analysis.…”

Preface to the special issue on systemic risk and financial networks

“…For example, credit freezes induced by the fear that future liquidity or borrower profitability would be compromised were observed during the 2007-2008 crisis [5]. Acemoglu et al (2020)'s paper [1] examines how fears of potential future default cascades can trigger ex-ante credit freezes, even before the realization of the actual adverse shocks. A contribution of their paper is illustrating how the nature of these credit freezes depend critically on the structure of the underlying financial network.…”